TABL2751 Business Taxation

THE UNIVERSITY OF NEW SOUTH WALES
AUSTRALIAN SCHOOL OF BUSINESS SCHOOL OF TAXATION AND BUSINESS LAW
TABL2751 – BUSINESS TAXATION
SEMESTER 2, 2018
University of New South Wales

ASSIGNMENT INSTRUCTIONS

You are required to submit an answer to the attached assignment question by the due date and time for lodgment. Any requests for extension must be made prior to the due date via e-mail to the lecturer-in-charge.

Your assignment must be submitted electronically via the link that will be made available on Moodle.

You should follow the ‘quick presentation and referencing guide’ which immediately follows the marking criteria at the end of this list of instructions. Failure to do so will be reflected in your mark for the assignment.

The word limit will be strictly enforced.

In preparing an answer, you will inevitably discuss issues raised by the assignment with other students. There is nothing in the UNSW rules prohibiting such discussions. However, in the end, you must be able to state that the work that you have submitted is your work. Importantly, you should ensure that you have not committed (either deliberately, or without intent) an act of plagiarism (e.g. presenting another’s work or ideas as your own, failing to acknowledge the source of a quotation, submitting the same or similar version of work to that of another student).

Given that this assignment is a problem type question that may require you to undertake research, no staff member working on this course, or any staff member in the School of Taxation & Business Law, will provide assistance to you in writing and researching your answer. Accordingly, please do not ask a staff member questions related to the assignment. If you require clarity in relation to any facts contained in the assignment question, these should be directed to the lecturer-in-charge.

Although the broad topics raised in the assignment will be topics covered in the course, the assignment will raise issues that will not necessarily have been discussed in lectures or tutorials. This means that you may have to go beyond the prescribed materials for the course in relation to some issues. Whilst you will not be given a separate mark for research, reading beyond the textbook / required readings may assist you in writing your answer.

You are welcome to source information from the ATO (particularly from Taxation Rulings or similar), but extensive reliance on ATO documents (and the ATO website) instead of legislation and case law will be reflected in your mark. You should use the ATO publications to support your understanding of the legislation, (and should reference any ATO materials appropriately), but you should not use it as a replacement for referring to legislation and cases.

If you are dissatisfied with your grade, you should review your assignment and the feedback given. Discussions regarding grades will not be entered into until you have reviewed your marked assignment. You should then discuss your grade with the lecturer-in-charge. If you are still dissatisfied with your grade, you are allowed to request a formal re-mark. Please note that such a re-mark can result in your grade either (i) staying the same; (ii) being increased; (iii) being reduced.

MARKING CRITERIA

Markers will be evaluating your assignments based on the following criteria:

Is it free of errors (such as spelling, grammatical or typographical errors)?

Does your assignment follow the “presentation and quick reference guide” included in this document?

Referencing

Your assignment must be fully and properly referenced. Failure to reference your sources is plagiarism and amounts to academic misconduct.

In your assignment, you will need to refer to, at a minimum, legislation and cases. You may also want to refer to a range of other material including government documents, books and websites. Provided in the below tables are some examples of how to cite these sources. Note that these are examples only – some of these will not be relevant for your assignment, and you will be expected to refer to sources that are not included in the table.

Table 1 (“Reference examples”) contains examples of how you should reference sources in your reference list. Table 2 (“Pinpoint reference examples”) contains examples of pinpoint referencing. This is when you refer to a specific page, paragraph or section. Your assignment should utilise pinpoint references as much as possible. Table 3 (“Subsequent reference examples”) contains examples of how you are allowed to reference the sources provided in Table 2 if you have already given the full reference in an earlier footnote.

Please note that for this assignment, I am allowing certain abbreviations and modifications that do not strictly follow the AGLC style guide. This is to simplify the referencing process for you. If you are studying further courses in the School of Taxation and Business Law, you should you follow the AGLC (or the referencing guide given in that course).

Australian Taxation Office, Income you must declare (20 May 2016) Australian Taxation Office <https://www.ato.gov.au/Individuals/Incomeand-deductions/Income-you-must-declare/>

(Note: the first reference to “Australian Taxation Office” is as the author of the webpage. The second reference to “Australian Taxation Office” is the title of the general website on which the document is located. The date is the last date the webpage was updated. Where there is not a full date available, as much of the date that is available should be included).

Frank Gilders et al, above n X, 412. “X” is the footnote number where you have first referred to this source. For example, if you had first referred to this source at footnote 10, the reference would be: Gilders et al, above n 10, 412.

Journal articles

Kraal, above n X, 218.

Websites

ATO, Income you must declare, above n “X”.

ASSIGNMENT QUESTION

Carson Pty Ltd (“Carson”), an Australian resident company for tax purposes, carries on numerous business activities.

In the first half of 2014, Carson has thoughts of expanding their operations, and conducts studies into the feasibility of manufacturing electric guitars for sale. The feasibility studies cost $8,000 (paid in March 2014). As a result of the feasibility studies, Carson decides to proceed with the venture.

On 1 July 2014, Carson purchases land with a derelict building on it in Victoria for $850,000. Between 1 July and 31 July 2014, Carson spends $80,000 on demolishing the derelict building. On 1 August 2014, Carson enters into a contract with Ramjet Pty Ltd (an Australian resident company for tax purposes) to construct a factory on the land so they can manufacture the electric guitars. The total cost of construction was $1,300,000 paid as follows:

A deposit of $200,000 on signing the contract (1 August 2014)

Four progress payments of $250,000 on the first of each subsequent month (i.e. 1 September 2014, 1 October 2014, 1 November 2014, 1 December 2014)

A final payment of $100,000 on 1 January 2015 when construction is completed.

To fund the venture, Carson had borrowed $1,600,000 from Aus Bank Ltd (an Australian resident bank) on 1 July 2014 on an interest only basis at a rate of 6% to partly fund the purchase of the land and the construction of the theatre building. Interest is payable on first (1st) of each month. (Note that an interest only loan means that only the interest is paid each month – no part of the principal is repaid). The balance of the purchase price and costs of construction were paid from Carson’s retained earnings. Carson paid stamp duty of $30,000 on the purchase of the land. Legal fees associated with the purchase of the land were $9,000.

As noted above, construction of the factory is completed on 1 January 2015. On 1 January 2015, Carson purchases the following equipment to manufacture electric guitars:

Item of equipment

Cost

Cost of transport / installation

Effective life

Machine A

$95,000

$5,000

5 years

Machine B

$210,000

$18,000

10 years

Machine C

$150,000

$10,000

8 years

Carson decides to use the prime cost method of depreciation for all pieces of equipment.

Manufacturing of guitars commences on 15 January 2015. Unfortunately, soon after manufacturing commences, Carson starts to gets complaints from neighbouring factories about the noise of manufacturing and testing the electric guitars. To solve this problem, noise reducing rubber is affixed to the walls and ceiling of the factory. Once it is affixed it is unable to be removed without causing significant damage to the underlying walls and ceiling. The installation of the rubber commences on 1 March 2015 and is completed on 15 March 2015. The total cost was $90,000 of which $15,000 was labour.

On 1 March 2018, Carson decides to sell the electric guitar manufacturing business.

The business sells for $3,000,000, allocated as follows:

$2,500,000: land and factory

$50,000: Machine A

$180,000: machine B

$120,000: Machine C

$150,000: Goodwill

The contract for the sale is signed on 1 June 2018. On receipt of the $3,000,000 (received on 15 July 2018), Carson repays the $1,600,000 bank loan to Aus Bank Ltd.

REQUIRED:

Advise Carson Pty Ltd on the tax consequences for each of the above transactions. This includes:

Advising Carson Pty Ltd as to whether, and if so when and to what extent, any of the above expenditures that it incurs will be deductible to in for Australian income tax purposes.

Advising Carson Pty ltd as to the tax consequences (including capital gains tax) on the sale of the business.

Further instructions / Notes:

Assume all figures are GST exclusive. You can ignore GST for the purposes of answering this question.

You can assume that Carson Pty Ltd is NOT a small business entity for tax purposes.

You are not required to calculate Carson Pty Ltd’s taxable income each year as you do not have the information to do so. Rather, you are meant to advise Carson Pty Ltd as to the deductibility of any of the expenditures (and the amount of those deductions); and the taxation consequences on sale of the business.

Introduction

The discussion objective of this assignment has two parts; the first one is to identify deductible items from case provided and the second one is to elaborate what impact does sales of land has on tax. In order to do so, we first need to recognize which item is deductible for tax purpose and explain it in relation to legislation s8-1 and div 43.12 Second, we need to refer to CGT event A1 and work out capital proceed, cost base or reduce cost base, then by comparing capital proceed with cost base or reduce cost base, we would be able to find out the consequence of disposal of land and factory.

Deduction

Deduction can be classified into s8-1 General deduction, S8-5 Specific deduction and Capital deduction under div40 & 43.345 Different expenditures due to its unique nature and characteristic are deducted under different categories.

Feasibility study

Anderson has spent $14,000 on feasibility study in order to determine whether this project should commence or not. This is similar to Softwood Pulp & Paper Ltd v FCT that the court states that the cost spent on study in relation to mill should not be deductible, as this cost is simply used to decide whether to establish the project or not and does not involve in the stage of doing anything in the course of carrying out a business to generate assessable income.6 Therefore this is a pre-commencement expenditure, and it is purely preliminary. On the other hand, Goodman fielder Wattie v FCT Case reinforces the point that feasibility study is irrelevant to the process of generating assessable income.7

Purchase of land

Referring to the S108-5 (1), any kind of property that person has control over can be regarded as CGT asset;8 Since purchase of land fulfills s8-1 (2), as cost associated is an outgoing of a capital, and it also fulfills Dixon’s criteria arises from Sun Newspaper limited v FCT by paying one off payment to obtain the character of advantage sought and those advantages are recurrence. 910 Therefore purchase of land $800,000 by Anderson on 1/07/2012 cannot be deducted under s8-1 (1) general deduction and specific deduction provision. However, since land is neither depreciating asset nor capital work, because it is exclude from capital expenditure according to s43-70, so it considered to be non deductible. 11 12

Demolishing Building

According to the fact of the case, Anderson has to spend $100,000 on demolishing the derelict building. This cost is necessarily incurred in order for Anderson to construct the factory; therefore it’s considered to be incidental and relevant to the production of assessable income, which means that it’s able to deduct under of S8-1 (1) legislation.13 On the other hand, although this cost can be included in 4th element of cost base as it’s an expenditure that relates to installing or moving;14 ATO TR2011/6 states that expenditures that forms part of the cost of land should not be deduct.15 Moreover, through the perspective of capital deduction s43-70, demolishing cost is excluded from construction expenditure, so it’s not able to deduct under this section.16

Construction of factory

Construct factory fee is the money spent in order to make the factory ready to manufacture computers and make assessable income. Therefore it’s an expenditure relates to installation and should be recognized as the 4th element of the cost base according to S110-25 (5).17 On the other hand, based on the fact that the construction fee is a not arises in the ordinary operation of the business but relate to profit making structure of the business; therefore it’s a capitalized expenditure and it’s not deductible under S8-1 (1).18 Moreover, combining the fact with div43-75and div43-85 legislation, once the construction is finished, a separate expenditure area is created applies to the situation stated in the case. 19 20 Indeed, the total $1,300,000 of construction expenditure is attribute to the construction expenditure – factory; therefore construction should be deducted under div43-10capital work provision.21 Besides, in relation to s43-145 4% of rate should be applied to the calculation of deduction every year, as it is an industrial activity; and no deduction should be calculated until the construction is completed.22 Detailed shown below:

Annual deduction: $1,300,000 x 4% = $52,000

Year

Amount

2013.01.01-2013.06.30

$52,000 * 181/365 = $25,786

2013.07.01-2014.06.30

$52,000

2014.07.01-2015.06.30

$52,000

2015.07.01-2015.11.01

$52,000 * 123/365 = $17,523

Total deduction amount

$147,309

Bank loan and Interest

According to s25-25 borrowing expense legislation of specific deduction provision, bank loan borrowed by Anderson Company on of $1,600,000 is not deductible due to the reason that only cost incurred in relation to borrowing is an allowable deduction;23 borrowing itself is not deductible. However, the interest incurred when borrowing loan is the cost of the use of the fund, and according to Ure v FCT Case if the borrowed money has been solely laid out for generating assessable income, then the interest would be wholly deductible.24 This statement is support by S8-1 (1), which also claims that interest is deductible as a cost of securing fund that are applied to the production of assessable income and is also supported by Case FCT v Munro.2526 Calculation is shown below

Annual interest payment of loans: $1,600,000 x 5% = $80,000

Year

Amount

2012.07.01-2013.06.30

$80,000

2013.07.01-2014.06.30

$80,000

2014.07.01-2015.06.30

$80,000

2015.07.01-2015.12.01

$80,000 * 153/365 = $33,534

Total deduction amount

$273,534

Borrowing Expense

Anderson Company paid $10,000 commission fees to banker and $10,000 application fees to bank when deriving bank loan. Due to the reason that loan is a long term benefit, so it’s considered to be capital, and those fees arises associated with loan should not be deductible under s8-1 (1).27 Hence, base on the fact states in the case, both commission fees and application fees are costs spend in relation to raising bank loan; therefore both fees are the initial cost of borrowing and is an allowable deduction under S25-25.28 In order to calculate the deduction, according to s25-25 (4) method statement the loan Anderson borrows has a life over 20 years, therefore deduction should be calculate over 5 years time.29 However, with the repayment of loan by Anderson on1/12/2015， the period calculated for deduction amount should be adjusted to the date Anderson made repayment, that means the remaining borrowing expense $4,400 should be deducted in once between 01/01/2015 to 01/12/2015.

Year

Amount

2012.07.01-2013.06.30

$11,000 x 365/1248 = $2,200

2013.07.01-2014.06.30

$8,800 x 365/883 = $2,200

2014.07.01-2015.06.30

$6,600 x 365/518 = $2,200

2015.07.01-2015.12.01

$4,400 x 153/153 = $4,400

Stamp duty and legal fee

Stamp duty fee of $15,000 and legal fee of $3000 has incurred associated with the purchase of land on 1/07/2012. Moreover, because both costs are one-off payment related to profit making structure of the company, so both costs have capital in nature and they fit into the negative limb of general deduction s8-1 (2) (a), so it cannot be deductible under general deduction s8-1 (1).3031

Penalty

According to the case, the taxpayer is required to pay $500,000 for their misleading conduct. Div26 has states that some amounts cannot be deducted or cannot deduct in full; accordingly, penalty is one of the amounts that should not be deducted.32 Besides, Magna Alloys v FCT Case has indicates that any cost associated with breach of law is not deductible as long as the breach is within the time of proceeding incomegenerating activities.33 Relate to the fact of the case, Anderson’s false and misleading behavior has breached the Australian Consumer Law during the time period of generating assessable income, therefore $500,000 of penalty is consider to be unallowable deduction. Indeed, Mayne Nickless Ltd v FCT Case indicates the nondeductibility nature of penalty applied for breach of law during income-producing period thus penalty is non-deductible.34

Compensation

In the case, Anderson resulted in paying $700,000 compensation to consumers for its unlawful act. The payment can be applied to general deduction s8-1 to identity it’s deductibility.35 It would then seem that this compensation fees was not incurred in respect to gaining or producing any assessable income. Therefore it is not deductible. This is also supported by the Herald & Weekly Times Ltd v FCT Case.36

Legal Fee

Legal fee of $110,000 is charged to Anderson Company associated in relation to unsuccessfully defending the action. Herald Weekly Times Ltd v FCT Case claims that legal expenses have to exclude any capital, private or domestic nature.37 Legal expense is held to be deductible if it incurred as a consequence of the taxpayer’s daily operating and income-producing activities.38 Moreover, Magna Alloys v FCT case also indicates that even though penalties should not be claim as deductible, it does not mean legal fees are also not deductible.39 Overall, $110,000 of legal fees is wholly deductible according to those cases.

Commission and legal fee relate to sale of land

Cost of $25,000 paid for commission and $7,000 in legal fee in the scenario of selling the land with factory should be considered to have capital in nature and has nothing to do with gaining assessable income thus both costs are not deductible. Relating to legislation s110-35 (7) any costs incurred relate to CGT asset should be seen as 2nd element of the cost base, thus these two costs should be included when calculating net capital gain.40

Tax consequence for disposal of land

CGT Asset – Purchase of land

The approach to define what is a CGT asset is based on property law concepts, concern with the right recognized by court or equity and with concept of ownership. According to s108-5 (1), any kind of property that person has control over would be considered to be a CGT asset.41 Anderson’s situation fit into this legislation and therefore the land Anderson purchased is a CGT asset. However, factory was built after the purchase of land, it is a separate CGT asset which built on pre CGT land.

CGT Event- Disposal of Land and factory (capital proceed)

Anderson Company entered into a contract to sale land and factory on 1/11/2015; in return Anderson received $2,500,000. According to s104-10 (1), disposal of CGT asset belongs to CGT Event A1, and s104-10 (2) states that disposal of asset requires a change of ownership occurs from one to another.4243 Therefore all the facts states in problem case fulfill these requirements for CGT event to be established. Indeed, relate to general rule S116-20, capital proceed from CGT event equals to the money received in respect of the event happening, so $2,500,000 received is capital proceed.44

Analyses of cost base

1st element:

In respect to s110-25, $800,000 money paid for the land is the 1st element of the cost base, because it is the money Anderson paid to acquire the land.45 There should be considered when calculating net capital gain.

2nd element:

Land is a CGT asset, and according to S110-35 (7) any fees that are related to a CGT asset should be included in the 2nd element of cost base.46 Therefore $15,000 spent on stamp duty and $3,000 spent on legal fees arises along with purchase of land and should be included into 2nd element of cost base.

Besides, $25,000 spent on commission for agent and $7,000 legal fees of sale incurred associated with the sale of land and factory, therefore these costs are proved to be incidental cost relates to CGT asset, therefore should also be seen as 2nd element of cost base.

3rd element:

Cost of owning CGT asset, like interest on money, cost of maintaining, repairing and insuring should be included in this section. However, these costs are irrelevant to our problem case.

4th element:

Both $100,000 demolishing of derelict building and $1,300,000 construction of factory are costs in respect to installing or moving a CGT asset, therefore S110-25 (5) proves that these cost are 4th element of cost base.47 However, s110-40 claims that deductible expense is not included in cost base in order to avoid calculating double deduction in capital gain tax, therefore deduction of construction expenditure $147,309 should be excluded here.48

5th element:

expenditure to establish and defend title should be included in this section, but it’s irrelevant to problem case.

Calculation of Capital gain tax

Capital gain or loss will incur along with CGT events. Following calculation is based on content of Capital Gain Tax in relation to gain or loss from a CGT asset49:

Calculation of Net Capital Gain (loss) of CGT Event A1

Capital Proceed from sale

$2,500,000

Less Cost Base:

1st Element:

Acquisition price

$800,000

2nd Element:

Stamp Duty

$15,000

Legal Fees of purchase

$3,000

Commission paid to agent

$25,000

Legal fee of sale

$7,000

4th Element:

Demolishing of derelict building

$100,000

Construction of factory

$1,300,000

Less: Deduction of construction

($147,309)

Total Cost Base

$2,102,691

Net Capital Gain

$397,309

As the chart shown, the net capital gain resulted from the sale of land and factory is $397,309.

Conclusion

Acquisition of land, demolishing, construction of factory and some relevant costs are critically discussed and determined which expenditures are deductible at what time in what amount under Australian Income Tax purpose. On the other hand, tax consequence associated to the disposal of land and factory is analyzed under Income Tax Assessment Act and Capital Gain tax. As a result, Anderson Company can claim a total amount of $397,309 of capital gain as well as deduction amount for each elements discussed previously.